Welcome to another issue of Money on Your Terms.
The past couple weeks I have been focusing
on how to invest in dividend paying stocks to
give you the edge in creating wealth. This week
I will continue the journey by looking at another
key indicator to use to find those stellar businesses
that produce solid dividends. In the last sentence
I said stellar businesses not stocks. Remember,
we are looking for solid companies instead
of a stock price on the financial exchanges.
One of the most important parts of analyzing
a rock solid business listed on the stock exchange
is understanding the company’s debt structure.
While many investors simply look at the dividend yield,
it is vital that investors take a look under the hood
of the company. There are many moving parts
that make a business function which require a
huge bank roll of cash to keep it operating
while at the same time paying out a dividend
to keep the shareholders happy. We have to
find out if that bank roll will continue to grow
in the future and keep churning out that
dividend for us.
To spot these dividend stars a few tests need
to be performed. Last week I showed you how
to test the dividend by looking at the dividend
history for the past ten years. This week we
will focus on the strength of the balance sheet
by taking a look at the amount of debt on the
books. We must find out if the company is
financially sound enough to continue to pay
out the dividend over the long term.
I call it the financially fit test.
The lower the debt, the healthier the company.
Lots of big debt means less profit in the
future for dividends, as more and more profits
have to go toward debt service. When a company’s
debt service is continually rising, it is a negative sign.
We want to find companies that have debt
under control.
Now, everyone has gone to school, studied
for a test and received a grade on that test.
You already know how the grading system
works and have some sort of study habits
ingrained in you to do the homework. The best
part of doing this type of homework is you
will be getting paid with future dividends
and you don’t even need to pull an all-nighter.
Now let’s go to the school of wealth building.
The educational system functions under an
A through F grading system. Well, the financial
markets have a similar grading system in
place to determine the overall credit worthiness
of the company. Dating back to 1924, we can
thank the Fitch Group for introducing a simple
long-term credit rating system for companies
with an assigned alphabetic scale from ‘AAA’ to ‘D’.
Standards & Poors adopted the same system
and others have followed suit with similar ratings
including Morningstar which I use to find
the best of the best.
Here is how they grade companies:
Investment grade: ‘AAA’ to ‘BBB’
Non-Investment grade: ‘BB’ to ‘D’
Investment Grade:
AAA: the best quality companies, reliable and stable
AA: quality companies, a bit higher risk than AAA
A: economic situation can affect finance
BBB: medium class companies, which are satisfactory at the moment
Non-Investment grade: “Speculative Grade”
BB: more prone to changes in the economy
B: financial situation varies noticeably
CCC: currently vulnerable and dependent on favorable economic conditions to meet its commitments
CC: highly vulnerable, very speculative bonds
C: highly vulnerable, perhaps in bankruptcy or in arrears but still continuing to pay out on obligations
D: has defaulted on obligations and it will generally default on most or all obligations
NR: not publicly rated
Several years back I invested in General Motors,
one of the big three auto manufactures which
was given a speculative grade CCC. It was
about one year before the economy and financial
markets where starting to show signs of major
trouble. The reason I invested in the company
was solely based on the current dividend yield.
I thought it was impossible for one of the greatest
American stories in the US, with hundreds of
thousands of employees and billions upon
billions of dollars of revenue generated around
the world, to stop paying out the dividend.
I believed they were, “too big to fail.”
Well guess what! GM not only stopped paying
a dividend, the company filed for bankruptcy protection.
Right before GM was going under, it showed a debt
ratio of about 100. On the books the company
was virtually worthless, since its debts were more
than its equity. The company had to reorganize
their entire debt and they took a good portion
of my investment down with it.
So it is wise to forget about the yield alone
and put more attention on the amount of debt
the company has when picking winning businesses
in the stock market. You can get the credit rating
of a company by going to a user friendly website
like Morningstar.com. I find the website easy to
use when I want to perform the financially fit test
on a company.
So this summer put to use those study habits
you learned in school to find investment grade
businesses that will produce that cash cow
income for you.
Listen this Thursday at 8:00 pm PST to the
Money on Your Terms Show on blogtalkradio.com,
I will be talking in-depth about how to conduct
the financially fit test and also how to navigate
the Morningstar website so you can find your
next winning dividend paying stock.
If you find yourself struggling with money,
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If you would like to learn more about
the way to build wealth with dividend paying
stocks then purchase my bestselling book,
Money on Your Terms, on Amazon.com.
I give you the formula to get on the road
to achieve debt free financial independence.
Feel free to submit questions you have.
Send your questions to: tim@moneyonyourterms.com.
Please put “Ask Tim” in the email subject line.
I look forward to your questions.
Remember when it comes to your money,
it’s on your terms and no one else’s terms.
Tim
This blog is for educational purposes only.
The above should not be considered or construed
as individualized or specific investment advice.
All readers are advised to conduct their own
independent research or consult with a professional,
if necessary, before making investment decisions.
Financial markets involve risk. You should not rely
on any past performance as a guarantee of future
investment results.